2013
CONTENTS PAGE Report of the Directors 1 Independent Auditors Report 3 Consolidated Income Statement 4 Consolidated Statement of Comprehensive Income 5 Statement of Comprehensive Income 6 Consolidated Balance Sheet 7 Balance Sheet 8 Consolidated Statement of Changes in Equity 9 Statement of Changes in Equity 10 Consolidated Cash Flow Statement 11 Notes to the Financial Statements 1. Principal activities 12 2. Summary of significant accounting policies 12 3. Critical accounting estimates and judgements in applying accounting policies 42 4. Financial risk management 44 5. Fair values of assets and liabilities 113 6. Net interest income 126 7. Net fee and commission income 127 8. Net trading gain 127 9. Net gain on other financial assets 128 10. Other operating income 128 11. Net charge of impairment allowances 128 12. Operating expenses 129 13. Net gain from fair value adjustments on investment properties 129 14. Net gain/(loss) from disposal/revaluation of properties, plant and equipment 129 15. Taxation 130 16. Profit attributable to the equity holders of the Bank 131 17. Dividends 131 18. Retirement benefit costs 131 19. Directors, Senior Management s and Key Personnel s emoluments 132 20. Cash and balances with banks and other financial institutions 134 21. Financial assets at fair value through profit or loss 135 22. Derivative financial instruments 136 23. Advances and other accounts 144 24. Loan impairment allowances 144 25. Investment in securities 146 26. Investment in subsidiaries 151 27. Investment properties 152 28. Properties, plant and equipment 153 29. Other assets 156 30. Financial liabilities at fair value through profit or loss 156 31. Deposits from customers and hedge accounting 157 32. Other accounts and provisions 157 33. Assets pledged as security 158 34. Deferred taxation 158 35. Share capital 160 36. Reserves 161 37. Notes to consolidated cash flow statement 161 38. Contingent liabilities and commitments 162 39. Capital commitments 162 40. Operating lease commitments 163
CONTENTS PAGE 41. Litigation 164 42. Segmental reporting 164 43. Offsetting financial instruments 171 44. Transfers of financial assets 175 45. Loans to directors and officers 175 46. Significant related party transactions 175 47. Currency concentrations 178 48. Cross-border claims 179 49. Non-bank Mainland exposures 180 50. Ultimate holding company 180 51. Approval of financial statements 180 Unaudited Supplementary Financial Information 1. Regulatory capital for credit, market and operational risks 181 2. Capital requirements for credit risk 182 3. Credit risk under the internal ratings-based approach 184 4. Credit risk under the standardised (credit risk) approach 196 5. Counterparty credit risk-related exposures 199 6. Assets securitisation 203 7. Capital charge for market risk 204 8. Capital charge for operational risk 206 9. Equity exposures in banking book 206 Management of Risks 207 Corporate Governance 210 Business Review 217 Definitions 220
Report of the Directors The Directors are pleased to present their report together with the audited consolidated financial statements of Nanyang Commercial Bank, Limited (hereinafter as the Bank ) and its subsidiaries (together with the Bank hereinafter as the Group ) for the year ended 31 December 2013. Principal Activities The Bank is a licensed bank authorised under the Hong Kong Banking Ordinance. The principal activities of the Bank are provision of banking and related financial services. The principal activities of the Bank's subsidiaries are shown in Note 26 to the Financial Statements. Results and Appropriations The results of the Group for the year are set out in the consolidated income statement on page 4. The directors declared an interim dividend of HK$77 per share totaling HK$539,000,000 on 12 December 2013 which was paid on 30 December 2013. Reserves Details of movements in the reserves of the Group are set out in the consolidated statement of changes in equity on page 9. Donations Charitable and other donations made by the Group during the year amounted to approximately HK$793,000. Properties, Plant and Equipment Details of movements in properties, plant and equipment of the Group and the Bank are set out in Note 28 to the Financial Statements. Share Capital Details of the share capital of the Bank are set out in Note 35 to the Financial Statements. Directors The directors during the year and up to the date of this report are: Board of Directors Chairman: Zhou Zaiqun # Vice Chairman: Fang Hongguang Directors: Gao Yingxin # Li Jiuzhong # Zhu Yanlai # Chan Sai Ming Chang Hsin Kang* Lan Hong Tsung, David* Lau Hon Chuen* Zhuo Chengwen # (resigned on 12 August 2013) # Non-executive directors * Independent non-executive directors 1
Report of the Directors (continued) Directors (continued) In accordance with Article 81 of the Articles of Association of the Bank, Mr. Fang Hongguang, Mr. Gao Yingxin and Mr. Lan Hong Tsung, David retire at the forthcoming annual general meeting and, being eligible, offer themselves for re-election. Directors Interests in Equity or Debt Securities At no time during the year was the Bank or any of its holding companies, subsidiaries or fellow subsidiaries a party to any arrangements to enable the directors of the Bank to acquire benefits by means of the acquisition of shares in, or debentures of, the Bank or any other body corporate. Directors Interests in Contracts of Significance No contracts of significance, in relation to the Group's business to which the Bank or any of its holding companies, subsidiaries or fellow subsidiaries was a party and in which any of the Bank's directors had a material interest, whether directly or indirectly, subsisted at the end of the year or at any time during the year. Management Contracts No contracts concerning the management and administration of the whole or any substantial part of the business of the Bank were entered into or existed during the year. Compliance with the Banking (Disclosure) Rules The financial statements for the year ended 31 December 2013 comply with the requirements set out in the Banking (Disclosure) Rules under the Hong Kong Banking Ordinance. Auditors At the close of the 2013 annual general meeting held on 28 May 2013, PricewaterhouseCoopers retired as auditor of the Bank upon expiration of its term of office and Ernst & Young ( EY ) was appointed as new auditor of the Bank to hold office until the conclusion of the 2014 annual general meeting. The financial statements for the year 2013 have been audited by EY who will retire and offer themselves for re-appointment at the 2014 annual general meeting. On behalf of the Board Zhou Zaiqun Chairman Hong Kong, 20 March 2014 2
Ernst & Young 22/F, CITIC Tower 1 Tim Mei Avenue Central, Hong Kong Independent Auditors Report To the shareholders of Nanyang Commercial Bank, Limited (Incorporated in Hong Kong with limited liability) We have audited the consolidated financial statements of Nanyang Commercial Bank, Limited (the Bank ) and its subsidiaries (together, the Group ) set out on pages 4 to 180, which comprise the consolidated and company balance sheets as at 31 December 2013, and the consolidated income statement, the consolidated and company statements of comprehensive income, the consolidated and company statements of changes in equity and the consolidated cash flow statement for the year then ended, and a summary of significant accounting policies and other explanatory information. Directors responsibility for the consolidated financial statements The directors of the Bank are responsible for the preparation of consolidated financial statements that give a true and fair view in accordance with Hong Kong Financial Reporting Standards issued by the Hong Kong Institute of Certified Public Accountants and the Hong Kong Companies Ordinance, and for such internal control as the directors determine is necessary to enable the preparation of consolidated financial statements that are free from material misstatement, whether due to fraud or error. Auditors responsibility Our responsibility is to express an opinion on these consolidated financial statements based on our audit. Our report is made solely to you, as a body, in accordance with section 141 of the Hong Kong Companies Ordinance, and for no other purpose. We do not assume responsibility towards or accept liability to any other person for the contents of this report. We conducted our audit in accordance with Hong Kong Standards on Auditing issued by the Hong Kong Institute of Certified Public Accountants. Those standards require that we comply with ethical requirements and plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free from material misstatement. An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the consolidated financial statements. The procedures selected depend on the auditors judgement, including the assessment of the risks of material misstatement of the consolidated financial statements, whether due to fraud or error. In making those risk assessments, the auditors consider internal control relevant to the entity s preparation of consolidated financial statements that give a true and fair view in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the entity s internal control. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of accounting estimates made by the directors, as well as evaluating the overall presentation of the consolidated financial statements. We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our audit opinion. Opinion In our opinion, the consolidated financial statements give a true and fair view of the state of affairs of the Bank and of the Group as at 31 December 2013, and of the Group s profit and cash flows for the year then ended in accordance with Hong Kong Financial Reporting Standards and have been properly prepared in accordance with the Hong Kong Companies Ordinance. Ernst & Young Certified Public Accountants Hong Kong 20 March 2014 3
Consolidated Income Statement For the year ended 31 December Notes 2013 2012 Interest income 8,776,796 7,710,456 Interest expense (4,085,630) (3,777,643) Net interest income 6 4,691,166 3,932,813 Fee and commission income 1,075,126 822,777 Fee and commission expense (66,501) (67,598) Net fee and commission income 7 1,008,625 755,179 Net trading gain 8 97,221 147,216 Net (loss)/gain on financial instruments designated at fair value through profit or loss (16,193) 21,959 Net gain on other financial assets 9 52,496 16,601 Other operating income 10 75,470 57,109 Net operating income before impairment allowances 5,908,785 4,930,877 Net charge of impairment allowances 11 (369,967) (396,948) Net operating income 5,538,818 4,533,929 Operating expenses 12 (2,352,498) (1,946,297) Operating profit 3,186,320 2,587,632 Net gain from fair value adjustments on investment properties 13 169,414 178,766 Net gain/(loss) from disposal/revaluation of properties, plant and equipment 14 3,476 (6,627) Profit before taxation 3,359,210 2,759,771 Taxation 15 (530,553) (419,813) Profit for the year 2,828,657 2,339,958 Dividends 17 539,000 392,000 The notes on pages 12 to 180 are an integral part of these financial statements. 4
Consolidated Statement of Comprehensive Income For the year ended 31 December Notes 2013 2012 Profit for the year 2,828,657 2,339,958 Items that will not be reclassified subsequently to income statement: Premises: Revaluation of premises 794,564 1,388,296 Deferred tax 34 (119,553) (218,290) 675,011 1,170,006 Items that may be reclassified subsequently to income statement: Available-for-sale securities: Change in fair value of available-for-sale securities (624,520) 328,116 Release upon disposal of available-for-sale securities reclassified to income statement (31,292) (11,839) Amortisation with respect to available-for-sale securities transferred to heldto-maturity securities reclassified to income statement - (715) Deferred tax 34 117,817 (47,000) (537,995) 268,562 Change in fair value of hedging instruments under net investment hedges (41,055) (4,138) Currency translation difference 301,150 94,637 (277,900) 359,061 Other comprehensive income for the year, net of tax 397,111 1,529,067 Total comprehensive income for the year 3,225,768 3,869,025 The notes on pages 12 to 180 are an integral part of these financial statements. 5
Statement of Comprehensive Income For the year ended 31 December Notes 2013 2012 Profit for the year 2,410,506 2,072,764 Items that will not be reclassified subsequently to income statement: Premises: Revaluation of premises 775,889 1,379,172 Deferred tax 34 (114,777) (217,913) 661,112 1,161,259 Items that may be reclassified subsequently to income statement: Available-for-sale securities: Change in fair value of available-for-sale securities (494,573) 340,360 Release upon disposal of available-for-sale securities reclassified to income statement (22,303) (10,893) Amortisation with respect to available-for-sale securities transferred to heldto-maturity securities reclassified to income statement - (715) Deferred tax 34 83,082 (50,297) (433,794) 278,455 Currency translation difference 405 (35) (433,389) 278,420 Other comprehensive income for the year, net of tax 227,723 1,439,679 Total comprehensive income for the year 2,638,229 3,512,443 The notes on pages 12 to 180 are an integral part of these financial statements. 6
Consolidated Balance Sheet As at 31 December Notes 2013 2012 ASSETS Cash and balances with banks and other financial institutions 20 44,739,319 40,788,320 Placements with banks and other financial institutions maturing between one and twelve months 21,344,000 17,308,944 Financial assets at fair value through profit or loss 21 4,164,693 5,125,160 Derivative financial instruments 22 508,453 764,577 Advances and other accounts 23 155,316,751 138,032,685 Investment in securities 25 42,272,143 40,989,649 Investment properties 27 1,174,938 1,027,083 Properties, plant and equipment 28 6,969,237 6,224,995 Deferred tax assets 34 152,831 49,727 Other assets 29 3,741,595 1,442,298 Total assets 280,383,960 251,753,438 LIABILITIES Deposits and balances from banks and other financial institutions 28,846,029 20,262,071 Financial liabilities at fair value through profit or loss 30 4,433,736 4,975,073 Derivative financial instruments 22 343,156 459,607 Deposits from customers 31 198,160,417 185,533,717 Other accounts and provisions 32 15,229,501 9,998,985 Current tax liabilities 205,587 82,384 Deferred tax liabilities 34 865,545 828,380 Total liabilities 248,083,971 222,140,217 EQUITY Share capital 35 700,000 700,000 Reserves 36 31,599,989 28,913,221 Total equity 32,299,989 29,613,221 Total liabilities and equity 280,383,960 251,753,438 The notes on pages 12 to 180 are an integral part of these financial statements. Approved by the Board of Directors on 20 March 2014 and signed on behalf of the Board by: Fang Hongguang Director Lau Hon Chuen Director Chan Sai Ming Director Leung Ka Chun Secretary 7
Balance Sheet As at 31 December Notes 2013 2012 ASSETS Cash and balances with banks and other financial institutions 20 18,840,334 21,758,708 Placements with banks and other financial institutions maturing between one and twelve months 1,858,262 1,579,422 Financial assets at fair value through profit or loss 21 4,164,693 5,125,160 Derivative financial instruments 22 410,434 649,703 Advances and other accounts 23 98,373,617 89,917,821 Investment in securities 25 36,401,978 33,899,483 Investment in subsidiaries 26 8,171,067 8,171,067 Investment properties 27 1,126,510 979,670 Properties, plant and equipment 28 6,191,967 5,461,161 Deferred tax assets 34-662 Other assets 29 3,532,439 1,067,668 Total assets 179,071,301 168,610,525 LIABILITIES Deposits and balances from banks and other financial institutions 7,488,291 4,173,831 Financial liabilities at fair value through profit or loss 30 4,433,736 4,975,073 Derivative financial instruments 22 248,314 376,425 Deposits from customers 31 131,724,586 128,178,500 Other accounts and provisions 32 4,222,445 2,184,907 Current tax liabilities 162,987 67,322 Deferred tax liabilities 34 856,737 819,491 Total liabilities 149,137,096 140,775,549 EQUITY Share capital 35 700,000 700,000 Reserves 36 29,234,205 27,134,976 Total equity 29,934,205 27,834,976 Total liabilities and equity 179,071,301 168,610,525 The notes on pages 12 to 180 are an integral part of these financial statements. Approved by the Board of Directors on 20 March 2014 and signed on behalf of the Board by: Fang Hongguang Director Lau Hon Chuen Director Chan Sai Ming Director Leung Ka Chun Secretary 8
Consolidated Statement of Changes in Equity Reserve for fair value changes of Share capital Share premium Capital reserve Premises revaluation reserve availablefor-sale securities Regulatory reserve* Translation reserve Retained earnings Total At 1 January 2012 700,000 2,444,517 605 3,673,491 104,431 1,358,627 618,049 17,236,476 26,136,196 Profit for the year - - - - - - - 2,339,958 2,339,958 Other comprehensive income: Premises - - - 1,170,006 - - - - 1,170,006 Available-for-sale securities - - - - 269,101 - - (539) 268,562 Change in fair value of hedging instruments under net investment hedges - - - - - - (4,138) - (4,138) Currency translation difference - - - 939 (368) - 94,066-94,637 Total comprehensive income - - - 1,170,945 268,733-89,928 2,339,419 3,869,025 Release upon disposal of premises - - - (7,208) - - - 7,208 - Transfer from retained earnings - - - - - 188,384 - (188,384) - Dividends - - - - - - - (392,000) (392,000) At 31 December 2012 700,000 2,444,517 605 4,837,228 373,164 1,547,011 707,977 19,002,719 29,613,221 Reserve for fair value changes of Share capital Share premium Capital reserve Premises revaluation reserve availablefor-sale securities Regulatory reserve* Translation reserve Retained earnings Total At 1 January 2013 700,000 2,444,517 605 4,837,228 373,164 1,547,011 707,977 19,002,719 29,613,221 Profit for the year - - - - - - - 2,828,657 2,828,657 Other comprehensive income: Premises - - - 675,011 - - - - 675,011 Available-for-sale securities - - - - (537,995) - - - (537,995) Change in fair value of hedging instruments under net investment hedges - - - - - - (41,055) - (41,055) Currency translation difference - - - 3,500 (57) - 297,707-301,150 Total comprehensive income - - - 678,511 (538,052) - 256,652 2,828,657 3,225,768 Transfer from retained earnings - - - - - 397,969 - (397,969) - Dividends - - - - - - - (539,000) (539,000) At 31 December 2013 700,000 2,444,517 605 5,515,739 (164,888) 1,944,980 964,629 20,894,407 32,299,989 * In accordance with the requirements of the HKMA, the amounts are set aside for general banking risks, including future losses or other unforeseeable risks, in addition to the loan impairment allowances recognised under HKAS 39. The notes on pages 12 to 180 are an integral part of these financial statements. 9
Statement of Changes in Equity Reserve for fair value changes of Share capital Share premium Premises revaluation reserve availablefor-sale securities Regulatory reserve* Translation reserve Retained earnings Total At 1 January 2012 700,000 2,444,517 3,503,912 96,527 708,510 (5,929) 17,266,996 24,714,533 Profit for the year - - - - - - 2,072,764 2,072,764 Other comprehensive income: Premises - - 1,161,259 - - - - 1,161,259 Available-for-sale securities - - - 278,994 - - (539) 278,455 Currency translation difference - - - (432) - 397 - (35) Total comprehensive income - - 1,161,259 278,562-397 2,072,225 3,512,443 Transfer to retained earnings - - - - (216,526) - 216,526 - Dividends - - - - - - (392,000) (392,000) At 31 December 2012 700,000 2,444,517 4,665,171 375,089 491,984 (5,532) 19,163,747 27,834,976 Reserve for fair value changes of Share Premises Share revaluation availablefor-sale Regulatory Translation Retained capital premium reserve securities reserve* reserve earnings Total At 1 January 2013 700,000 2,444,517 4,665,171 375,089 491,984 (5,532) 19,163,747 27,834,976 Profit for the year - - - - - - 2,410,506 2,410,506 Other comprehensive income: Premises - - 661,112 - - - - 661,112 Available-for-sale securities - - - (433,794) - - - (433,794) Currency translation difference - - - - - 405-405 Total comprehensive income - - 661,112 (433,794) - 405 2,410,506 2,638,229 Transfer from retained earnings - - - - 98,905 - (98,905) - Dividends - - - - - - (539,000) (539,000) At 31 December 2013 700,000 2,444,517 5,326,283 (58,705) 590,889 (5,127) 20,936,348 29,934,205 * In accordance with the requirements of the HKMA, the amounts are set aside for general banking risks, including future losses or other unforeseeable risks, in addition to the loan impairment allowances recognised under HKAS 39. The notes on pages 12 to 180 are an integral part of these financial statements. 10
Consolidated Cash Flow Statement For the year ended 31 December Notes 2013 2012 Cash flows from operating activities Operating cash inflow/(outflow) before taxation 37(a) 5,927,086 (6,710,114) Hong Kong profits tax paid (354,140) (505,312) Overseas profits tax paid (118,751) (73,560) Net cash inflow/(outflow) from operating activities 5,454,195 (7,288,986) Cash flows from investing activities Purchase of properties, plant and equipment 28 (109,955) (429,519) Proceeds from disposal of properties, plant and equipment 720 5,502 Net cash outflow from investing activities (109,235) (424,017) Cash flows from financing activities Dividends paid (539,000) (392,000) Net cash outflow from financing activities (539,000) (392,000) Increase/(decrease) in cash and cash equivalents 4,805,960 (8,105,003) Cash and cash equivalents at 1 January 33,701,213 41,732,029 Effect of exchange rate changes on cash and cash equivalents 501,392 74,187 Cash and cash equivalents at 31 December 37(b) 39,008,565 33,701,213 The notes on pages 12 to 180 are an integral part of these financial statements. 11
Notes to the Financial Statements 1. Principal activities Nanyang Commercial Bank, Limited was incorporated in Hong Kong (hereinafter as the Bank ) and its subsidiaries were incorporated in Hong Kong or Shanghai (together with the Bank hereinafter as the Group ). The Bank is a licensed bank authorised under the Hong Kong Banking Ordinance. The principal activities of the Bank are the provision of banking and related financial services. The principal activities of the Bank s subsidiaries are shown in Note 26. The address of the Bank s registered office is 151 Des Voeux Road Central, Hong Kong. 2. Summary of significant accounting policies The principal accounting policies applied in the preparation of these consolidated financial statements are set out below. These policies have been consistently applied to all the years presented, unless otherwise stated. 2.1 Basis of preparation The consolidated financial statements of the Group have been prepared in accordance with Hong Kong Financial Reporting Standards (HKFRSs is a collective term which includes all applicable individual Hong Kong Financial Reporting Standards, HKASs and Interpretations) issued by the HKICPA and the requirements of the Hong Kong Companies Ordinance. The consolidated financial statements have been prepared under the historical cost convention, as modified by the revaluation of available-for-sale securities, financial assets and financial liabilities (including derivative financial instruments) at fair value through profit or loss, investment properties which are carried at fair value and premises which are carried at fair value or revalued amount less accumulated depreciation and accumulated impairment losses. The preparation of financial statements in conformity with HKFRSs requires the use of certain critical accounting estimates. It also requires the Management to exercise judgement in the process of applying the Group s accounting policies. The areas involving a higher degree of judgement or complexity, or areas where assumptions and estimates are significant to the consolidated financial statements are disclosed in Note 3. 12
2. Summary of significant accounting policies (continued) 2.1 Basis of preparation (continued) (a) Standards, amendments and interpretation already mandatorily effective for accounting periods beginning on 1 January 2013 Standard/Interpretation Content Applicable for financial years beginning on/after Currently relevant to the Group HKAS 1 (Revised) Presentation of Financial Statements 1 July 2012 Yes HKAS 19 (2011) Employee Benefits 1 January 2013 Yes HKAS 27 (2011) Separate Financial Statements 1 January 2013 Yes HKAS 28 (2011) HKFRS 1 (Amendment) Investments in Associates and Joint Ventures First Time Adoption of Hong Kong Financial Reporting Standards Government Loans 1 January 2013 No 1 January 2013 No HKFRS 7 (Amendment) Financial Instruments: Disclosures Offsetting Financial Assets and Financial Liabilities 1 January 2013 Yes HKFRS 10 Consolidated Financial Statements 1 January 2013 Yes HKFRS 11 Joint Arrangements 1 January 2013 No HKFRS 12 Disclosure of Interests in Other Entities 1 January 2013 No HKFRS 10, 11 and 12 (Amendment) Transition Guidance 1 January 2013 Yes HKFRS 13 Fair Value Measurement 1 January 2013 Yes HK(IFRIC) Int 20 Stripping Costs in the Production Phase of a Surface Mine 1 January 2013 No HKAS 1 (Revised), Presentation of Financial Statements. The amendments to HKAS 1 (Revised) require companies preparing financial statements in accordance with HKFRSs to group together items within other comprehensive income (OCI) that may be reclassified to the income statement. The amendments also reaffirm existing requirements that items in OCI and profit or loss should be presented as either a single statement or two consecutive statements. The adoption of this revised standard affects the presentation of the Group s statement of comprehensive income. HKAS 19 (2011), Employee Benefits. The revised standard mainly amends the part related to accounting for changes in defined benefit obligations and plan assets, and related presentation and disclosure. The amendments do not have impact on the Group s financial statements. 13
2. Summary of significant accounting policies (continued) 2.1 Basis of preparation (continued) (a) Standards, amendments and interpretation already mandatorily effective for accounting periods beginning on 1 January 2013 (continued) HKAS 27 (2011), Separate Financial Statements. Please refer to the below on HKFRS 10, Consolidated Financial Statements. HKFRS 7 (Amendment), Financial Instruments: Disclosures Offsetting Financial Assets and Financial Liabilities. The amendments require new disclosures to include information that enable users of an entity s financial statements to evaluate the effect or potential effect of netting arrangements, including rights of set-off associated with the entity s recognised financial assets and recognised financial liabilities, on the entity s financial position. New disclosure for the adoption of this amended standard is presented in Note 43. HKFRS 10, Consolidated Financial Statements. HKFRS 10 builds on existing principles by identifying the concept of control as the determining factor when considering whether an entity should be included within the consolidated financial statements of the parent company. The standard provides additional guidance to assist in the determination of control where this is difficult to assess. It also replaces all of the guidance on control and consolidation stipulated in HKAS 27 (Revised), Consolidated and Separate Financial Statements, and HK(SIC)-Int 12, Consolidation Special Purpose Entities. The remainder of HKAS 27 (Revised) is renamed as HKAS 27 (2011), Separate Financial Statements as a standard dealing solely with separate financial statements without changing the existing guidance for separate financial statements. 14
2. Summary of significant accounting policies (continued) 2.1 Basis of preparation (continued) (a) Standards, amendments and interpretation already mandatorily effective for accounting periods beginning on 1 January 2013 (continued) The above HKFRS 10, HKFRS 11, HKFRS 12, HKAS 27 (2011) and HKAS 28 (2011) issued in June 2011 are a group of five new standards that supersede HKAS 27 (Revised), HKAS 28, HKAS 31, HK(SIC)-Int 12 and HK(SIC)-Int 13. The adoption of these standards does not have a material impact on the Group s financial statements. HKFRS 10, 11 and 12 (Amendment), on transition guidance. The amendments provide additional transition relief to HKFRS 10, 11 and 12, limiting the requirement to provide adjusted comparative information to only the preceding comparative period. The adoption of this amendment does not affect the disclosure of the Group s financial statements. HKFRS 13, Fair Value Measurement. The new standard which was issued in June 2011 replaces the fair value measurement guidance contained in individual HKFRSs by providing a revised definition of fair value and a single source of fair value measurement and disclosure requirements for use across HKFRSs. The requirements do not extend the use of fair value accounting, but provide guidance on how it should be applied when its use is already required or permitted by other standards within HKFRSs. It also requires extensive disclosures which allow users of financial statements to assess the methods and inputs used by the entities when developing the fair value measurements. The new disclosure is presented in Note 5. 15
2. Summary of significant accounting policies (continued) 2.1 Basis of preparation (continued) (b) Standards, amendments and interpretation issued that are not yet mandatorily effective and have not been early adopted by the Group in 2013 The following standards, amendments and interpretation have been issued and are mandatory for accounting periods beginning on or after 1 January 2014: Standard/Interpretation HKAS 19 (2011) (Amendment) Content Employee Benefits: Defined Benefit Plans Applicable for financial years beginning on/after 1 July 2014 No Currently relevant to the Group HKAS 32 (Amendment) Financial Instruments: Presentation Offsetting Financial Assets and Financial Liabilities 1 January 2014 Yes HKAS 36 (Amendment) HKAS 39 (Amendment) Impairment of Assets: Recoverable Amount Disclosures for Non-Financial Assets Financial Instruments: Recognition and Measurement Novation of Derivatives and Continuation of Hedge Accounting 1 January 2014 Yes 1 January 2014 Yes HKFRS 7 (Amendment) Financial Instruments: Disclosures Transition to HKFRS 9 1 January 2015 Yes HKFRS 9 Financial Instruments To be determined Yes HKFRS 10, 12 and HKAS 27 (Amendments) Investment Entities 1 January 2014 No HK(IFRIC) Int 21 Levies 1 January 2014 Yes HKAS 32 (Amendment), Financial Instruments: Presentation Offsetting Financial Assets and Financial Liabilities. The amendment addresses inconsistencies in current practice when applying the offsetting criteria and clarifies the meaning of currently has a legally enforceable right of set-off ; and the application of offsetting criteria to some gross settlement systems (such as central clearing house systems) that may be considered equivalent to net settlement. The adoption of this amendment does not have a material impact on the Group s financial statements. HKAS 36 (Amendment), Impairment of Assets: Recoverable Amount Disclosures for Non-Financial Assets. The amendment aligns the disclosure requirements with its original intention which does not intend to disclose at level of cash generating unit. It also requires additional disclosure about the fair value measurement when the recoverable amount of impaired assets is based on fair value less costs of disposal. The adoption of this amendment does not affect the disclosure of the Group s financial statements. 16
2. Summary of significant accounting policies (continued) 2.1 Basis of preparation (continued) (b) Standards, amendments and interpretation issued that are not yet mandatorily effective and have not been early adopted by the Group in 2013 (continued) HKAS 39 (Amendment), Financial Instruments: Recognition and Measurement Novation of Derivatives and Continuation of Hedge Accounting. The amendment introduces a relief to allow hedge accounting to continue in a situation where a derivative, which has been designated as a hedging instrument, is novated to effect clearing with a central counterparty as a result of laws or regulation. The adoption of this amendment does not have a material impact on the Group s financial statements. HKFRS 7 (Amendment), Financial Instruments: Disclosures Transition to HKFRS 9. The amendments provide relief from the requirement to restate comparative financial statements which was originally available only to entities that chose to apply HKFRS 9 prior to 2012. Instead, additional transition disclosures will be required to help users to better understand the effect of initial application of the standard. HKFRS 9, Financial Instruments. The first part of HKFRS 9 was issued in November 2009 and will replace those parts of HKAS 39 relating to the classification and measurement of financial assets. In November 2010, a further pronouncement was published to address financial liabilities and derecognition. In December 2013, the part related to hedge accounting was further added. Key features are as follows: (i) Classification and Measurement Financial assets are required to be classified into one of the following measurement categories: (1) those to be measured subsequently at fair value or (2) those to be measured subsequently at amortised cost. Classification is to be made on transition, and subsequently on initial recognition. The classification depends on the entity s business model for managing its financial instruments and the contractual cash flow characteristics of the instrument. A financial instrument is subsequently measured at amortised cost only if it is a debt instrument, and the objective of the entity s business model is to hold the asset to collect the contractual cash flows, and the asset s contractual cash flows represent only unleveraged payments of principal and interest. All other debt instruments are to be measured at fair value through profit or loss. 17
2. Summary of significant accounting policies (continued) 2.1 Basis of preparation (continued) (b) Standards, amendments and interpretation issued that are not yet mandatorily effective and have not been early adopted by the Group in 2013 (continued) (i) Classification and Measurement (continued) All equity instruments are to be measured subsequently at fair value. Equity instruments that are held for trading will be measured at fair value through profit or loss. For all other equity investments, an irrevocable election can be made at initial recognition to recognise unrealised and realised fair value gains and losses through other comprehensive income rather than the income statement. Once elected to be recognised through other comprehensive income, there will be no reclassification of fair value gains and losses to the income statement. (ii) Financial Liabilities and Derecognition Except for the two substantial changes described below, the classification and measurement requirements of financial liabilities have been basically carried forward with minimal amendments from HKAS 39. For the derecognition principles, they are consistent with that of HKAS 39. The requirements related to the fair value option for financial liabilities were changed to address own credit risk. It requires the amount of change in fair value attributable to changes in the credit risk of the financial liabilities be presented in other comprehensive income. The remaining amount of the total gain or loss is included in the income statement. If this requirement creates or enlarges an accounting mismatch in profit or loss, then the whole fair value change is presented in the income statement. The determination of whether there will be a mismatch will need to be made at initial recognition of individual liabilities and will not be re-assessed. Amounts presented in other comprehensive income are not subsequently reclassified to the income statement but may be transferred within equity. The standard also eliminates the exception from fair value measurement contained in HKAS 39 for derivative liabilities that are linked to and must be settled by delivery of an unquoted equity instrument. (iii) Hedge accounting The requirements related to hedge accounting relaxes the requirements for assessing hedge effectiveness which more risk management strategies would be eligible for hedge accounting. It also relaxes the rules on using purchased options and non-derivative financial instruments as hedging instruments and allows greater flexibility on the hedged items. Corresponding disclosures about risk management activity for applying hedge accounting are also introduced. 18
2. Summary of significant accounting policies (continued) 2.1 Basis of preparation (continued) (b) Standards, amendments and interpretation issued that are not yet mandatorily effective and have not been early adopted by the Group in 2013 (continued) It is expected that the final part on impairment of financial assets will be pronounced in 2014. HKAS 39 will be replaced by HKFRS 9 in its entirety. The previous mandatory effective date of HKFRS 9 was removed and the new mandatory effective date will be determined upon the entire completion of HKFRS 9. Early adoption of HKFRS 9 is permitted but the part of classification and measurement and hedge accounting must be applied at the same time. The accounting for own credit risk can be early adopted in isolation without applying the other HKFRS 9 requirements at the same time. The Group is considering the financial impact of the standard and the timing of its application. HK(IFRIC) Int 21, Levies. The interpretation addresses how an entity should account for liabilities to pay levies imposed by governments, other than income taxes, in its financial statements. For a levy that is triggered upon reaching a minimum threshold, no liability should be anticipated before the specified minimum threshold is reached. The adoption of this amendment does not have a material impact on the Group s financial statements. (c) Improvements to HKFRSs Improvements to HKFRSs contains numerous amendments to HKFRSs which the HKICPA considers not urgent but necessary. It comprises amendments that result in accounting changes for presentation, recognition or measurement purpose as well as terminology or editorial amendments related to a variety of individual HKFRSs. The amendments are either effective and adopted for annual periods beginning on or after 1 January 2013 or will be effective on or after 1 July 2014. The adoption of these improvements does not have a material impact on the Group s financial statements. 2.2 Consolidation The consolidated financial statements include the financial statements of the Bank and all of its subsidiaries made up to 31 December. Subsidiaries Subsidiaries are entities controlled by the Group. Control is achieved when the Group is exposed, or has rights, to variable returns from its involvement with the investee and has the ability to affect those returns through its power over the investee. The existence and effect of potential voting rights that are currently exercisable or convertible are considered when assessing whether the Group controls another entity. Subsidiaries are fully consolidated from the date on which control is transferred to the Group. They are de-consolidated from the date that control ceases. 19
2. Summary of significant accounting policies (continued) 2.2 Consolidation (continued) Inter-company transactions, balances and unrealised gains on transactions between Group companies are eliminated; unrealised losses are also eliminated unless the transaction provides evidence of impairment of the assets transferred. Where necessary, accounting policies of subsidiaries have been changed to ensure consistency with the policies adopted by the Group. In the Bank s balance sheet, the investments in subsidiaries are stated at cost less allowance for impairment losses. The results of subsidiaries are accounted for by the Bank on the basis of dividends received and receivable. Dividend income from subsidiaries is recognised in the income statement when the right to receive payment is established. 2.3 Segmental reporting The operating result of segments are reported in a manner consistent with the internal reporting provided to the Management, which is the chief operating decision maker of the Group, that allocates resources and assesses the performance of operating segments. Income and expenses directly associated with each segment are included in determining operating segment performance. 20
2. Summary of significant accounting policies (continued) 2.4 Foreign currency translation Items included in the financial statements of each of the Group s entities are measured using the currency of the primary economic environment in which the entity operates (the functional currency ). The consolidated financial statements are presented in Hong Kong dollars, which is the Bank s functional and presentation currency. Foreign currency transactions are translated into the functional currency using the exchange rates prevailing at the dates of the transactions or exchange rates at the end of the reporting period for items that are re-measured. Foreign exchange gains and losses resulting from the settlement of foreign currency transactions using the exchange rates prevailing at the dates of the transactions and monetary assets and liabilities denominated in foreign currencies translated at the exchange rate at the end of the reporting period are recognised directly in the income statement, except when deferred in other comprehensive income as qualifying cash flow hedges and qualifying net investment hedges. Translation differences on monetary securities held at fair value through profit or loss are reported as part of the fair value gain or loss. Changes in the fair value of monetary securities denominated in foreign currency classified as available-for-sale are analysed between translation differences resulting from changes in the amortised cost of the securities and other changes in the carrying amount of the securities. Translation differences related to changes in the amortised cost are recognised in the income statement, and other changes in the carrying amount are recognised in other comprehensive income. Translation differences on non-monetary items, such as equities held at fair value through profit or loss, are reported as part of the fair value gain or loss. Translation differences on non-monetary financial assets such as equities classified as available-for-sale are included in other comprehensive income. The results and financial position of all the Group entities that have a functional currency different from Hong Kong dollars are translated into Hong Kong dollars as follows: assets and liabilities are translated at the closing rate at the end of the reporting period; income and expenses are translated at average exchange rates; and all resulting exchange differences are recognised in the currency translation reserve in equity through other comprehensive income. On consolidation, exchange differences arising from the translation of the net investment in foreign entities, and of borrowings and other currency instruments designated as hedges of such investments are taken to other comprehensive income. When a foreign entity is sold, such exchange differences are recognised in the income statement, as part of the gain or loss on sale. 21
2. Summary of significant accounting policies (continued) 2.5 Derivative financial instruments Derivatives are initially recognised at fair value on the date the derivative contract is entered into and are subsequently remeasured at fair value. Fair values are obtained from quoted market prices in active markets, including recent market transactions, and through the use of valuation techniques, including discounted cash flow models and option pricing models, as appropriate. All derivatives are carried as assets when fair value is positive and as liabilities when fair value is negative. Certain derivatives embedded in other financial instruments are treated as separate derivatives when their economic characteristics and risks are not closely related to those of the host contract and the host contract is not carried at fair value through profit or loss. These embedded derivatives are measured at fair value with changes in fair value recognised in the income statement. Derivatives are categorised as held for trading and changes in their fair value are recognised immediately in the income statement unless they are designated as hedges and are effective hedging instruments, then they are subject to measurement under the hedge accounting requirements. 2.6 Hedge accounting The Group documents at inception the relationship between hedging instruments and hedged items, as well as its risk management objective and strategy for undertaking various hedge transactions. The Group also documents its assessment, both at the hedge inception and on an ongoing basis, of whether the derivatives that are used in hedging transactions are highly effective in offsetting changes in fair values of hedged items. These criteria should be met before a hedge can be qualified to be accounted for under hedge accounting. 22
2. Summary of significant accounting policies (continued) 2.6 Hedge accounting (continued) Net investment hedge A gain or loss on the effective portion of the hedging instrument is recognised in other comprehensive income and accumulated in equity; a gain or loss on the ineffective portion is recognised immediately in the income statement. Accumulated gains and losses previously recognised in other comprehensive income are reclassified to the income statement upon disposal of the foreign operation as part of the gain or loss on disposal. 2.7 Offsetting financial instruments Financial assets and liabilities are offset and the net amount reported in the balance sheet when there is a legally enforceable right to offset the recognised amounts and there is an intention to settle on a net basis, or realise the asset and settle the liability simultaneously. 23
2. Summary of significant accounting policies (continued) 2.8 Interest income and expense and fee and commission income and expense Interest income and expense are recognised in the income statement for all financial assets and financial liabilities using the effective interest method. The effective interest method is a method of calculating the amortised cost of a financial asset or a financial liability and of allocating the interest income or interest expense over the relevant period. The effective interest rate is the rate that exactly discounts estimated future cash payments or receipts through the expected life of the financial instrument or, when appropriate, a shorter period to the net carrying amount of the financial asset or financial liability. When calculating the effective interest rate, the Group estimates future cash flows considering all contractual terms of the financial instrument (e.g. prepayment options or incentives relating to residential mortgage loans) but does not consider future credit losses. The calculation includes fees, premiums or discounts and basis points paid or received between parties to the contract, and directly attributable origination fees and costs which represent an integral part of the effective yield. Once a financial asset or a group of similar financial assets has been written down as a result of an impairment loss, interest income is recognised on the written down value using the rate of interest used to discount the future cash flows for the purpose of measuring the impairment loss. Subsequent unwinding of the discount allowance is recognised as interest income. Fee and commission income and expenses that are not an integral part of the effective yield are recognised on an accrual basis ratably over the period when the related service is provided, such as administrative fee, asset management fee and custody services fee. Loan syndication fees are recognised as revenue when the related syndication arrangement has been completed and the Group has retained no part of the loan package for itself or has retained a part at the same effective interest rate as that of other participants. 24
2. Summary of significant accounting policies (continued) 2.9 Financial assets The Group classifies its financial assets into the following four categories: financial assets at fair value through profit or loss, loans and receivables, held-to-maturity securities and available-for-sale financial assets. The Management determines the classification of investments at initial recognition. The classification depends on the purpose for which the financial assets are held. All financial assets are recognised initially at fair value. Except for financial assets carried at fair value through profit or loss, all transaction costs of financial assets are included in their amortised costs. (1) Financial assets at fair value through profit or loss This category has two sub-categories: financial assets held for trading, and those designated at fair value through profit or loss at inception. A financial asset which has been acquired or incurred principally for the purpose of selling in the short term or is part of a portfolio of identified financial instruments that are managed together and for which there is evidence of a recent actual pattern of short-term profit-taking is classified as held for trading. Derivatives are also classified as held for trading. A financial asset, other than one held for trading, will be designated as a financial asset at fair value through profit or loss, if it meets one of the criteria set out below, and is so designated by the Management: eliminates or significantly reduces a measurement or recognition inconsistency (sometimes referred to as an accounting mismatch ) that would otherwise arise from measuring the financial assets or recognising the gains and losses on them on different bases; or applies to a group of financial assets, financial liabilities or both that is managed and its performance is evaluated on a fair value basis, in accordance with a documented risk management or investment strategy, and information about the group is provided internally on that basis to the Management; or relates to financial assets containing one or more embedded derivative that significantly modifies the cash flow resulting from those financial assets. 25